EXCERPTED FROM
Foreign Investment and
Domestic Development:
Multinationals and the State
Jenny Rebecca Kehl
Copyright © 2009
ISBN: 978-1-58826-633-0 hc
1800 30th Street, Ste. 314
Boulder, CO 80301
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Contents
List of Illustrations
ix
1 Introduction:
The Political Economy of Development
2 The Politics of Profit:
Foreign Investment as a Development Strategy
3 Roadblocks:
Ineffective Bureaucracies in Kenya
4 Corruption:
Impeding Pioneer Industries in Nigeria
5 Growing Pains:
Securing the Benefits of High Tech Investment in India
6 Joint Ventures:
Developing a Business Class in Malaysia
7 Adelante: Government Commitments to Reduce
Investment Risk in Chile
8 After NAFTA: Attracting Multinationals with
Free Enterprise Zones in Mexico
9 Looking Forward: The Trajectory of Foreign
Investment and Domestic Development
Appendix: Research Notes
Bibliography
Index
About the Book
1
11
47
59
71
85
97
105
117
133
143
155
163
vii
1
Introduction:
The Political Economy
of Development
THE DEVELOPING WORLD RELIES ON GLOBAL markets to stimulate
growth and generate wealth. Yet, in this time of great global opulence,
trillions of dollars flow through the developing world without altering
its reality of poverty and scarcity. At the turn of the century, the world’s
fifty largest foreign investors in the developing world held $1.8 trillion
in foreign assets and $2.1 trillion in sales.1 Amartya Sen, Nobel laureate
in economic sciences, contrasts this unprecedented amount of wealth in
the international economy with the “remarkable deprivation, destitution
and oppression” observed in most of the world.2 There is a growing discrepancy between the substantial foreign investment in the developing
world and the sparse resources available for domestic development. The
global market alone has failed to reverse this trend. However, the size of
the global economy is expected to quadruple in the next fifty years, with
the majority of the growth in foreign direct investment (FDI). This
growth has the potential to increase the financial and capital resources
available to promote development in poor countries. The expansion of
FDI offers developing countries the opportunity to increase their integration into the global market and to develop investment patterns that
maximize their possibilities for economic growth.
In this book I examine the crucial relationship between foreign
direct investment and domestic economic development. Foreign direct
investment can be an asset to developing countries by providing
employment, capital, revenue, trade, and technology. Most underdeveloped countries, however, lack the institutional capacity to negotiate
mutually beneficial investment arrangements with multinational corporations. Weak political institutions and perverse economic policies make
developing countries easily exploitable. Nevertheless, as this study
1
2
Foreign Investment and Domestic Development
demonstrates, developing countries can in fact gain greater benefits
from hosting foreign investment, without deterring future investment.
The essential strategies for gaining greater benefits from foreign
investment are political, not economic. Political institutions mediate the
conflict of interest and the disparity of power between multinational
corporations and host governments in order to maximize benefits and
minimize externalities. In the chapters that follow, I provide crossnational evidence that domestic benefits from foreign investment are
contingent on government capacity, democratic accountability, regulatory standardization, and development policies that maximize freedom of
production and consumption. I also compare the distinct investment
arrangements of General Motors Corporation, one of the world’s largest
foreign direct investors, in Mexico, India, Nigeria, Kenya, Chile, and
Malaysia. This innovative multimethod approach exposes the negotiation strategies of host governments and General Motors, and provides a
much-needed assessment of the outcomes of investment arrangements
for developing countries and multinational corporations.
Not all developing countries have been able to benefit from the
promise and prosperity of foreign investment. Poor countries cannot
rely on the altruistic intentions of foreign investors to promote domestic
development. Most multinational corporations are more highly organized and have more money than the countries in which they invest. This
gives them leverage to negotiate lucrative, and often exploitative, deals
with fledgling governments in poor countries. There is an important
ongoing narrative about how foreign investment leads to exploitation.
But that is not the narrative of this research. My purpose is to demonstrate how developing countries can manage foreign investment to promote domestic development.
The benefits and externalities of hosting FDI are largely a function of how well governments negotiate initial investment arrangements. Accordingly, I address the following questions: What specific
strategies are successful in negotiating mutually beneficial investment
arrangements between countries and corporations with asymmetrical
bargaining power? Are there discernible differences in domestic political institutions and economic policies that generate distinct patterns
of foreign direct investment? What determines the success or failure
of developing countries to utilize foreign investment to promote
domestic development? Previous research has focused almost exclusively on how to attract foreign investment. This study focuses on
how to utilize it.
Introduction
3
The Role of Political Institutions
Political institutions provide incentives and impose constraints on foreign investment. Governments rely on institutions to resolve political
problems, coordinate economic activities, and implement strategies to
promote development. In the case of foreign investment, the capacity of
developing countries to negotiate mutually beneficial investment agreements is contingent on the ability of political institutions to achieve
specified goals.3 Political institutions must be able to manage resources,
react to political and economic challenges, predict and prevent crises,
and achieve policy results.
The World Bank’s Global Development Finance Report suggests
that good policies and good governance, along with strong institutions,
are critical to using private foreign investment inflows productively. 4
When governments decide to host foreign investment as part of an economic development strategy, political institutions often determine the
success or failure to maximize domestic benefits and minimize negative
externalities. Political institutions moderate competing interests, mediate asymmetrical power, develop codes of conduct, and specify the
rights and responsibilities of foreign corporations and host governments.
Recognizing the explanatory value of political institutions challenges the alternative explanation of economic determinism. The relationship between foreign direct investment and domestic development
cannot be explained entirely by economic variables. Chapter 2 elaborates on the alternative economic explanations. However, as Frances
Hagopian and Samuel Huntington argue, “economic forces are indeterminant [sic]; their influence on outcomes must be filtered through
political institutions.”5 The political institutional framework suggests
that institutions are central to good economic governance.
Governments develop institutions to raise revenue and stimulate economic growth in response to political and economic interests.6 To satisfy these interests, institutions have become “larger, considerably more
complex and resourceful, and prima facie more important,”7 particularly in developing countries. There is, however, wide variation in the
capacity of governments to establish effective institutions to meet political demands and economic needs in the developing world. In this
study I analyze several indicative political variables—including regime
type, accountability, transparency, political stability (political risk),
regulation of production practices, performance requirements, and government effectiveness—in order to determine what specific institutional
4
Foreign Investment and Domestic Development
arrangements are successful at achieving good economic governance in
developing countries.
The Role of Political Economy
The political economy approach argues that development is driven by a
combination of market mechanisms and government decisions. On a
spectrum from laissez-faire to command economies, governments often
make deliberate political decisions for economic reasons.8 Government
policies may have calculated effects on the market through rules of commerce, fiscal policy, regulation, taxation, expenditure, production, and
consumption. I examine these economic indicators in Chapter 2, in
accordance with the new institutional economics theory established by
Douglass North, Ronald Coase, and Robert Fogel.9 This theory suggests
that it is the underlying institutional framework that determines the success or failure of efforts to establish market-oriented strategies that promote economic growth.
In the case of using foreign investment as part of a development
strategy, governments may choose to intervene in production or consumption in order to maximize the profitability of the investment. The
liberal theory of political economy suggests that governments must
determine their level of intervention in the economy based on the consequences for the market. Pure laissez-faire liberalism advocates a minimal level of government intervention in the economy. However, most
political economy theories of development acknowledge that the state is
clearly a key actor for countries in the developing stages.10
The political economy framework suggests that governments intervene, minimally, in market systems to provide an environment that is
conducive to economic growth, to arbitrate between government policy
goals and those of individuals and firms, 11 and to compensate those
adversely affected.12 Political economy theory parallels political institutional theory regarding the “coordination” of market forces. However,
political economy emphasizes the importance of factors such as market
access, market size, trade practices, taxation, and the level of intervention in market forces, while the political institutional approach focuses
on variables such as institutional accountability, political stability, government capacity, and policy implementation. The political economy
framework advocates for economic neoliberalism as the guiding principle for coordinating market forces. Although neoliberalism has been
Introduction
5
hotly debated at the theoretical level, the evidence in support of free
trade is almost undisputed in the industrialized countries. The picture in
the developing countries, however, is quite different. As political economist A. F. K. Organski argues, the poorer the country, the more important are political factors.13
A Mixed Reception for Foreign Investment
Foreign investors receive a wide variety of receptions in developing
countries. India is an emerging economy that welcomes foreign
investors into government-financed High Tech City buildings that are
designed to impress modern multinational corporations. These buildings
have backup energy sources to compensate for the regular power outages in India, as well as emergency flight plans to transport employees
to the nearest High Tech City if their computer systems collapse. The
facilities allow foreign investors to conduct business without disruptions
in energy supplies or computer communications, which is a luxury that
most domestic businesses do not have. Foreign companies have been
highly successful in High Tech City locations in India. For example,
General Motors has orchestrated the Chevrolet Indian Revolution, “a
love affair with the Chevy”14 that has generated hundreds of millions in
revenue. This illustrates a warm reception for foreign investors from the
Indian government and consumers. But not everyone shares the love
affair with foreign investors. The train bombings in Mumbai in 2006
specifically targeted business commuters on their way to work in modern High Tech City locations for foreign firms such as IBM, Nestlé,
Nokia, and General Electric.
Malaysia has developed technology corridors, similar to India’s
High Tech City buildings, and Mexico has designated maquiladora
zones as free enterprise zones to welcome foreign investors. Multinational corporations often receive tax breaks, corporate subsidies, labor
concessions, toxic-emission exemptions, and other incentives to conduct
business in technology corridors and maquiladora zones. However,
political officials and business leaders in both countries have accused
foreign investors of creating expensive externalities and failing to honor
their initial contracts. In Mexico the outcomes of these disputes are
determined largely by the North American Free Trade Agreement, which
favors the foreign firms. In Malaysia the central bureaucracy normally
governs over foreign investment, but the bureaucracy’s power is limited
6
Foreign Investment and Domestic Development
in free enterprise zones. Similar arrangements exist in free enterprise
zones worldwide to maximize the freedom of production and consumption for multinational corporations.
Even with free enterprise zones, African countries have had trouble
marketing their economies as destinations for FDI. They have been
scrambling to receive foreign investors and have undercut each other in
a race to the bottom—promising to minimize benefits for the host country in order to maximize profits for the foreign investors. Many African
countries agree to forego tax revenue; allow profits to be repatriated
rather than reinvested; give away resource rights, mining rights, drilling
rights, and valuable raw materials; and absorb the cost of negative externalities in order to attract foreign investors. Despite these concessions,
there are sectors that gain benefits from hosting foreign investment,
such as oil in Nigeria, agriculture in Kenya, and manufacturing in South
Africa. Although the relationship between foreign investment and
domestic development is tenuous throughout the continent, African
countries continue to welcome foreign investors because they need the
capital, employment, technology, and revenue that those investors generate. It is unrealistic and counterproductive to discourage African countries from receiving foreign investment as part of a development strategy. It is more productive to examine a variety of strategies that poor
countries can use to improve their investment arrangements by maximizing benefits and minimizing negative externalities.
Organization of the Book
This book is designed to demonstrate how developing countries can
manage foreign investment to promote domestic economic growth. “The
Politics of Profit: Foreign Investment as a Development Strategy,”
Chapter 2, examines the political institutions and economic policies that
affect the benefits and externalities from hosting foreign direct investment. Here I examine FDI arrangements using a cross-national analysis
of 147 developing countries across 35 years (1971–2006). I test the significance of three competing explanations—political institutional, political economy, and a synergistic model—and examine globalization, diffusion, and the learning process across states. The dynamics of diffusion
and the causal mechanisms of change are illustrated in the case studies
of Kenya, Nigeria, India, Malaysia, Chile, and Mexico.
Chapter 3, “Road Blocks: Ineffective Bureaucracies in Kenya,” and
Chapter 4, “Corruption: Impeding Pioneer Industries in Nigeria,” analyze the consequences of weak political institutions and inconsistent
Introduction
7
economic reforms in the African region. The case of Kenya demonstrates how ineffective bureaucracy and political instability can result in
divestment, while the Nigerian case exposes the debilitating effects of
corruption.
Chapter 5, “Growing Pains: Securing the Benefits of High Tech
Investment in India,” and Chapter 6, “Joint Ventures: Developing a
Business Class in Malaysia,” demonstrate how institutional capacity has
expedited the process of foreign investment and domestic development.
India’s arrangements with General Motors reveal successful strategies for
attracting and utilizing foreign investment to achieve rapid economic
growth, despite contradictions between a large labor pool and a small tax
base, as well as hidden costs of increasing inequality. The case of
Malaysia’s contracts with General Motors illustrates the impact of centralized government on investment arrangements, which has allowed
Malaysia to enforce requirements on employment and technology transfer.
Chapter 7, “Adelante: Government Commitments to Reduce
Investment Risk in Chile,” and Chapter 8, “After NAFTA: Attracting
Multinationals with Free Enterprise Zones in Mexico,” focus on the
importance of reducing political risk and the dynamics of foreign direct
investment in Latin America. They also correct several of the inaccurate
myths about what foreign investors consider to be compelling incentives
and constraints. Mexico’s arrangements with General Motors also highlight the effects of superstructures on the relationship between foreign
investment and domestic development, showing how the North
American Free Trade Agreement has determined most of the interregional incentives and constraints for foreign investment.
The concluding chapter of the book, “Looking Forward: The
Trajectory of Foreign Investment and Domestic Development,” provides
a synopsis of the research and offers projections about the modernization of investment negotiations and development strategies. The
research findings demonstrate that the quality of the investment environment, rather than the quantity of investment, determines profitability for
both investors and host countries. The findings also highlight the discernible differences in political institutions that result in distinct patterns
of investment.
Notes
Thank you to Rutgers University–Camden, faculty colleagues I have thanked in
person, and the Office of Sponsored Research and Programs for the support and
resources to complete this project. Special thanks also to James Scarritt for his
insight and expertise.
8
Foreign Investment and Domestic Development
1. United Nations Conference on Trade and Development. World
Investment Report. 2003. FDI Policies for Development: National and
International Perspectives. New York: United Nations.
2. Amartya Sen. 1999. Development as Freedom. New York: Random
House, p. xi. Sen was Nobel laureate in economic sciences in 1998.
3. Marina Arbetman and Jacek Kugler (eds.). 1997. Political Capacity
and Economic Behavior: The Political Economy of Global Interdependence.
Boulder, CO: Westview Press; David Leblang. 1997. “Political Capacity and
Economic Growth.” In Political Capacity and Economic Behavior, edited by
Marina Arbetman and Jacek Kugler. Boulder, CO: Westview Press.
4. World Bank. 2004. Global Development Finance Report 2004.
Washington, DC: World Bank Group, pp. 64–65.
5. Frances Hagopian. 2000. “Political Development, Revisited,”
Comparative Political Studies 33: 893; Samuel Huntington. 1968. Political
Order in Changing Societies. New Haven, CT: Yale University Press.
6. Margaret Levi. 1997. “A Model, a Method, and a Map: Rational
Choice in Comparative and Historical Analysis.” In Comparative Politics:
Rationality, Culture, and Structure, edited by Mark Lichbach and Alan
Zuckerman. Cambridge: Cambridge University Press; Margaret Levi, 1988, Of
Rule and Revenue. Berkeley: University of California Press; Avner Greif, Paul
Milgrom, and Barbara Weingast. 1994. “Coordination, Commitment, and
Enforcement: The Case of the Merchant Guild,” Journal of Political Economy
102: 745–776.
7. James March and Johan Olson. 1984. “The New Institutionalism:
Organized Factors in Political Life.” American Political Science Review 78:
734.
8. Kenneth Arrow. 1951. Social Choice and Individual Values. New
Haven, CT: Yale University Press; Anthony Downs. 1957a. “Causes and Effects
of Rational Voter Abstention.” In An Economic Theory of Democracy. New
York: Harper; Anthony Downs. 1957b. An Economic Theory of Democracy.
New York: Harper; William Riker. 1982. Liberalism Against Populism: A
Confrontation Between the Theory of Democracy and the Theory of Social
Choice. San Francisco: W. H. Freeman and Mancur Olson. 1971. The Logic of
Collective Action: Public Goods and the Theory of Groups. Cambridge, MA:
Harvard University Press; Douglass North. 1981. Structure and Change in
Economic History. New York: Norton; Douglass North. 1990. Institutions,
Institutional Change, and Economic Performance. New York: Cambridge
University Press; Margaret Levi. 1988. Of Rule and Revenue. Berkeley:
University of California Press.
9. Douglass North. 1999. Understanding the Process of Economic
Change. London: Institute of Economic Affairs and the London Business
School. Douglass North and Robert Fogel are 1993 Nobel laureates in economic
sciences; Ronald Coase, 1991 Nobel laureate in economic sciences.
10. Marina Arbetman and Jacek Kugler (eds.). 1997. Political Capacity
and Economic Behavior: The Political Economy of Global Interdependence.
Boulder, CO: Westview, p. 15.
11. Ibid.
12. Peter Katzenstein. 1985. Small States in World Markets. Ithaca, NY:
Cornell University Press.
Introduction
9
13. A. F. K. Organski. 1997. “Theoretical Link of Political Capacity to
Development.” Pp. 47–66 in Political Capacity and Economic Behavior, edited
by Marina Arbetman and Jacek Kugler. Boulder, CO: Westview.
14. Sandeep Raj Singh. January 29, 2007. “General Motors India on a
Roll,” Company News, New Delhi, General Motors India, p. 5.